Thursday, July 9, 2009

EPS Accretion (Dilution) in Acquisitions

There are two major ways to fund acquisitions. Either raise debt (borrow money) or raise equity (get owners to contribute more capital or find more investors).

In each case, there are major factors which affect the ending EPS.

In debt, the largest effect on the EPS through the income statement is the interest expense. For a large enough debt issuance, the interest expense can rise to a level which adversely affects EPS (dilution).

In equity, the largest dilution effect on EPS is from the dilution through the number of outstanding stocks (equity raised divided by the market value of the stock).

In each case, it requires M&A analysts to do sensitivity tests to find the effect on dilution based on different premium values above the stock value as well as the amount of leverage applied (how much capital should be raised by debt versus equity).

Assuming rational investors, the sensitivity analysis should provide a fairly definitive decision criteria for the acquisition decision as well as guidance for the amount of leverage to be applied.

No comments: